1 Will CGT event E1 or CGT event E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 (ITAA 1997) happen as a result of making the proposed variations to the Trust Deed for the Trust?
No. Question 2 Are the Units 'pre-CGT assets' of the Trust as set out in section 149-10 of the Income Tax Assessment Act 1997 (ITAA 1997)? Answer Yes. This ruling applies for the following period : Income year ending 30 June XXXX
The Trust was established pursuant to the terms of the trust deed dated before 20 September 1985. The Trustee power to amend the Trust Deed provides that: (l) Notwithstanding anything hereinbefore contained the Trustee shall have power - ... (v) from time to time and at any time prior to the distribution date to alter or vary all or any of the trusts herein declared concerning the Trust Fund or any part thereof or the income or any part thereof to arise therefrom to such ends intents and purposes as the Trustee may in his absolute discretion from time to time think fit provided that the power by this clause given shall not be exercised in such manner as to result in a trustee hereof having a more valuable interest hereunder than he or she had prior to such exercise. Relevantly, the proposed amendments to the Trust Deed: • Amends the vesting date. • Amends the meaning of beneficiary to include any body corporate of which any individual beneficiary or individual beneficiaries of this Trust have an inalienable right to receive more than 50% of the income and capital of that body corporate. The underlying assets of the Trust are Units acquired before 20 September 1985
All entities are Australian residents for income tax purposes.
Income Tax Assessment Act 1936 section 160ZZS Income Tax Assessment Act 1997 section 108-5 Income Tax Assessment Act 1997 section 104-55 Income Tax Assessment Act 1997 section 104-60 Income Tax Assessment Act 1997 Division 149
Question 1 Summary On the basis of the assumption that the amendments are valid, i.e. that the proposed variations to the Trust Deed will amend the terms of the Trust Deed pursuant to a valid exercise of a power contained within the Trust Deed, the amendments will not cause the Trust to terminate and a new trust to arise for trust law purposes (it will not lead to any asset of the Trust being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust). In that case, neither CGT event E1 nor CGT event E2 will happen as a result of making the proposed variations to the Trust Deed - noting that where a proposed change is beyond the power conferred by the terms of a trust, it will be of no effect and, therefore, cannot give rise to a resettlement of the trust, and would not result in CGT event E1 or E2 happening. Detailed reasoning Subsection 104-55(1) of the ITAA 1997 provides that CGT event E1 happens if you create a trust over a CGT asset by declaration or settlement.
Subsection 104-60(2) of the ITAA 1997 provides that CGT event E2 happens if you transfer a CGT asset to an existing trust. In the Full Federal Court case of Commissioner of Taxation v Clark [2011] FCAFC 5 ( Clark ), it was established that a trust will not be terminated provided that any amendment to the trust is made in accordance with a power conferred by the trust instrument and there is some continuity of property and membership of the trust. Following Clark , the Commissioner issued Taxation Determination TD 2012/21 Income tax: does CGT event E1 or E2 in sections 104-55 or 104-60 of the Income Tax Assessment Act 1997 happen if the terms of the trust are changed pursuant to a valid exercise of a power contained within the trust's constituent documents, or varied with the approval of a relevant court? (TD 2012/21). In TD 2012/21 the Commissioner expresses the view that in the circumstances where the terms of a trust are changed pursuant to a valid exercise of a power contained within the trust's constituent document, or varied with the approval of a relevant court, neither CGT event E1 nor CGT event E2 in sections 104-55 or 104-60 of the ITAA 1997 happens unless:
the change causes the existing trust to terminate and a new trust to arise for trust law purposes, or the effect of the change or court approved variation is such as to lead to a particular asset being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust. Paragraph 24 of TD 2012/21 explains that the Commissioner accepts that a change in the terms of a trust pursuant to an existing power (including an amendment to the deed of a trust) will not result in the termination of the trust. Paragraph 27 of TD 2012/21 states that even in instances where a pre-existing trust does not terminate, it may be the case that assets held originally as part of the trust property commence to be held under a separate charter of obligations as a result of a change to the terms of the trust - whether by exercise of a power under the deed (including a power to amend) or court approved variation - such as to lead to the conclusion that those assets are now held on terms of a distinct (that is, different) trust.
The Commissioner accepts the general proposition that where there is some continuity of property and membership of the trust, changes to the terms of a trust that are made in proper exercise of a power of amendment will not terminate the trust where they are properly supported by that power. Accordingly, the scope of the amendment power and the validity of its exercise in a particular case will be critical. Application in these circumstances In this case, the Trust was established by the Trust Deed which constitutes the Trust's constituent document. The facts of this ruling contain an assumption that the Trustee has the power to amend the Trust Deed in accordance with the proposed amendments. In accordance with the assumption: The proposed amendments will not result in the termination of the Trust, provided that the amendments are validly made within the scope of the amendment power. The proposed amendments will not, if valid, result in any assets of the Trust being held on new and different trusts.
The proposed variations do not affect the composition of the trust property, or the obligations under which the assets comprising the trust property are held. There is continuity of property and membership of the trust - the main asset of the Trust will continue to be held for the benefit of the family group. The proposed variations to the Trust Deed will amend the terms of the Trust Deed pursuant to a valid exercise of a power contained within the Trust Deed - the amendments will not cause the Trust to terminate and a new trust to arise for trust law purposes (it will not lead to any asset of the Trust being subject to a separate charter of rights and obligations such as to give rise to the conclusion that that asset has been settled on terms of a different trust). Consequently, neither CGT event E1 nor CGT event E2 will happen as a result of making the proposed variations to the Trust Deed. That is, on the basis of the assumption that the amendments are valid, and in accordance with the views expressed in TD 2012/21, neither CGT event E1 or E2 will happen by reason of the variation of the trust instrument.
It should be noted that where a proposed change is beyond the power conferred by the terms of a trust, it will be of no effect. Therefore, it cannot give rise to a resettlement of the trust, and would not result in CGT event E1 or E2 happening. Question 2 Summary The Units acquired before 20 September 1985 are pre-CGT assets of the Trust pursuant to section 149-10 of the ITAA 1997. Detailed reasoning Division 149 of the ITAA 1997 Division 149 of the ITAA 1997 contains the provisions under which an asset acquired before 20 September 1985 is treated as having been acquired after that date, that is, the asset stops being a pre-CGT asset. Subdivision 149-B of the ITAA 1997 provides for when the asset of an entity stops being a pre-CGT asset for entities that are not covered by section 149-50 of the ITAA 1997. Effectively, Subdivision 149-B deals with non-public entities. A CGT asset is defined in subsection 108-5(1) of the ITAA 1997 as any kind of property or a legal or equitable right that is not property. A CGT asset is a pre-CGT asset if it was last acquired before 20 September 1985 and no income tax provision has operated to treat it as having been acquired after that date.
Section 149-10 of the ITAA 1997 provides as follows: A CGT asset that an entity owns is a pre-CGT asset if, and only if: (a) the entity last acquired the asset before 20 September 1985; and (b) the entity was not, immediately before the start of the 1998-99 income year, taken under: (i) former subsection 160ZZS(1) of the Income Tax Assessment Act 1936; or (ii) Subdivision C of Division 20 of former Part IIIA of that Act; to have acquired the asset on or after 20 September 1985; and (c) the asset has not stopped being a pre-CGT asset of the entity because of this Division. Section 149-30 of the ITAA 1997 provides that an asset of a non-public entity stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. Subsection 149-15(3) of the ITAA 1997 relevantly defines an 'ultimate owner' to include an individual. It does not include companies that pay dividends to their members, or trusts.
Subsection 149-15(2) of the ITAA 1997 defines an 'underlying interest' in a CGT asset as a beneficial interest that an ultimate owner has (whether directly or indirectly) in the asset or in any ordinary income that may be derived from the asset. Subsection 149-15(1) of the ITAA 1997 defines majority underlying interests. It requires ultimate owners to hold more than 50% of the beneficial interests (either directly or indirectly through one or more interposed companies, trusts or partnerships) in the CGT asset and in any ordinary income that may be derived from the asset. Subsections 149-15(4) and (5) of the ITAA 1997 provide that an ultimate owner has an indirect beneficial interest in a CGT asset of another entity if they would receive for their own benefit any capital or ordinary income distributed by the entity through interposed entities.
Under subsection 149-30(2) of the ITAA 1997, if the Commissioner is satisfied, or thinks it reasonable to assume, that the majority underlying interests in the asset have not changed up to a particular time, then subsections 149-30(1) and (1A) of the ITAA 1997 apply and the asset continues to be a pre-CGT Asset. Simply put, subsection 149-30(2) of the ITAA 1997 requires that the Commissioner has to be satisfied that the majority underlying interests in the assets have not changed, otherwise the asset is deemed to have been acquired at the time that the change in majority underlying interests in that asset happened. In this case, as the Units acquired prior to 20 September 1985 are not held directly by individuals, the underlying interests in the Units need to be traced through intermediary entities to the ultimate owners for the whole period from and including 20 September 1985. Taxation Ruling IT 2340 Income tax: capital gains: deemed acquisition of assets by a taxpayer after 19 September 1985 where a change occurs in the underlying ownership of assets acquired by the taxpayer on or before that date
(IT 2340) adopts a pragmatic approach of looking through interposed entities to determine which natural persons hold the beneficial interests for the purposes of section 160ZZS of the Income Tax Assessment Act 1936 (ITAA 1936), which preceded Division 149 of the ITAA 1997. Among other things, IT 2340 deals with issues regarding the application of section 160ZZS of the ITAA 1936 'to assets held by trustees of family trusts where the trustees are vested with discretionary powers as to distributions from the trusts. Taxation Ruling IT 2340 reflects the position that section 160ZZS of the ITAA 1936, by its terms, necessarily supplants normal legal concepts of interests in assets. For the purposes of section 160ZZS, a beneficiary of a discretionary trust is treated as having a beneficial interest in the trust's assets. Likewise, a shareholder is treated for the purposes of section 160ZZS of the ITAA 1936 as having a beneficial interest in the company's assets. Under this approach the Commissioner can 'look through' an entity to determine who are the natural persons who hold beneficial interests in assets :
2. The terms "underlying interest" and "majority underlying interests", on the basis of which the provision operates, have the same meanings as they have in Subdivision G of Division 3 of Part III of the Act - which deals with the income tax treatment of interest in relation to "negatively geared" investments in rental property. In both cases (and like other provisions of the Act concerned with the measurement of ownership interests) underlying interests in relation to the assets concerned mean beneficial interests held by natural persons whether directly or through one or more interposed companies, partnerships or trusts. The clear policy of the law thus permits and requires that, for the purposes of the relevant provisions, chains of companies, partnerships and trusts are to be "looked through" in order to determine whether there has been a change in the effective interests of natural persons in the assets. IT 2340 sets out the Commissioner's approach in respect of 'looking through' discretionary family trusts to determine whether majority underlying interests have been maintained in the assets of the trust, as follows:
5. In relation to what are generally referred to as discretionary trusts, i.e., family trusts, the trustees of which have discretionary powers as to the distribution of trust income or property to beneficiaries, in considering the question of whether majority underlying interests have been maintained in the assets of the trust it will be relevant to take into account the way in which the discretionary powers of the trustees are in fact exercised. 6. Where a trustee continues to administer a trust for the benefit of members of a particular family, for example, it will not bring section 160ZZS into application merely because distributions to family members who are beneficiaries are made in such amounts and to such of those beneficiaries as the trustee determines in the exercise of his discretion.
7. In such a case the Commissioner would, in terms of sub-section 160ZZS(1), find it reasonable to assume that for all practical purposes the majority underlying interests in the trust assets have not changed. That is consistent with the role of the section to close potential avenues for avoidance of tax in cases where there is a substantial change in underlying ownership of assets and the legislative guidance contained in Subdivision G of Division 3 of Part III of the Act. On that basis, trust assets acquired by the trustee before 20 September 1985 would remain outside the scope of the capital gains and losses provisions of the Act. However, if the trustee of a family discretionary trust appoints new beneficiaries who are not members of the particular family group, the Commissioner may consider that the underlying interests in the trust assets has changed. Paragraph 8 of IT 2340 states:
8. On the other hand where, by the exercise of a trustee's discretionary powers to appoint beneficiaries or by amendment of the trust deed, there is in practical effect a change of 50% or more in the underlying interests in the trust assets - such as where the members of a new family are substituted as recipients of distributions from the trust in place of persons who were formerly the object of such distributions - the section would have its intended application as described. Application in these circumstances
Relevantly, the proposed changes to Trust Deed includes an amendment to the meaning of beneficiary to include any body corporate of which any individual beneficiary or individual beneficiaries of this Trust have an inalienable right to receive more than 50% of the income and capital of that body corporate. Consequently, in these circumstances, more than 50% of the income and capital cannot be channelled to certain shareholders (in particular, shareholders who are not individual members of the family group. Accordingly, the ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985 will receive more than 50% of the ordinary income and capital that may be derived from the asset. There will be no change in the ultimate owners who had a majority underlying interest in the asset immediately before 20 September 1985 and, therefore, subsection 149-30(1) of the ITAA 1997 will not operate to cause the asset to stop being a pre-CGT asset.
In these circumstances, the Commissioner is satisfied that the changes will not interrupt the continuity of the Trust as the Trustee of the Trust will continue to administer the Trust for the benefit of the family members. Accordingly, it is reasonable for the Commissioner to assume that the majority underlying interests in the Units will be held by the same ultimate owners who held such interests immediately before 20 September 1985 for the purposes of Division 149 of the ITAA 1997.